What  Constitutes  a Reasonable 
Underwriting  Profit 

and 

The  Method  of  Determining 
Same 


NATIONAL  BOARD  OF  FIRE  UNDERWRITERS 

ACTUARIAL  BUREAU  COMMITTEE 

NEW  YORK 
1920 


Certain  queries  were  embodied  in  resolutions 
presented  at  the  annual  meeting  of  the  National  Con- 
vention of  Insurance  Commissioners  held  in  Hartford 
in  September,  1919,  which  resolutions  were  transmitted 
to  F.  C.  Buswell,  President  of  the  National  Board  of 
Fire  Underwriters  under  date  of  October  25,  1919,  by 
Honorable  Joseph  Button,  Commissioner  of  Insurance 
of  the  Commonwealth  of  Virginia  and  Chairman  of  the 
Committee  on  Fire  Insurance  of  the  Commissioners’ 
Convention. 

The  following  constitutes  a partial  answer  to  the 
questions  thus  propounded. 


5.  / S 


5G5,\ 


FIRST 

^ WHAT  CONSTITUTES  A REASONABLE  UNDER- 
WRITING  PROFIT? 

An  equitable  regard  for  the  investors  who  furnish  Reasonable 
the  capital  for  this  particularly  hazardous  business 
would  indicate  that  5^  is  the  minimum  percentage 
which  can  he  regarded  as  “a  reasonable  underwriting 
profit.”  This  has  already  been  recognized  as  equitable 
by  several  states. 

The  Method  of  Determining  Same  (Whether  Paid  or 
Earned  Premiums,  and  Paid  or  Incurred  Losses 
and  Expenses)  ? 

The  laws  of  the  several  states  very  properly  require  Earned 
that  the  portion  of  the  PREMIUMS  unearned  he  set  Premiums, 
aside  in  a reserve  fund  until  such  earnings  accrue.  Since 
the  company’s  surplus  is  augmented  only  by  the  portion 
of  the  premiums  earned  and  removed  from  such  reserve 
and  only  the  portion  earned  can  be  treated  as  an  ele- 
ment in  computing  the  profit  result  as  shown  in  the 
annual  statements  made  in  accordance  with  such  legal 
requirements,  companies  should  not  he  expected  to  re- 
turn the  full  amount  of  premiums  paid  in,  but  only  such 
amount  as  is  earned. 

As  to  LOSSES,  the  principle  is  even  more  obvious  Incurred  Losses. 
that  incurred  losses,  and  not  paid,  is  the  only  proper 
basis.  A simple  and  convincing  illustration  of  this  prin- 
ciple is  afforded  by  the  case  of  a company  which  suffers 
a conflagration  loss,  or  losses  of  considerable  magnitude, 
just  prior  to  the  end  of  the  year.  In  reporting  on  a paid 
basis  such  losses  would  not  appear  at  all,  owing  to  the 
fact  that  there  had  not  been  sufficient  opportunity  to 
V.  adjust  and  pay  them  before  the  end  of  the  year;  con- 
sequently,  the  result  would  be  wholly  inaccurate  and 
misleading. 

^ q 

<=^  ^ 

^ 49976 


Incurred 

Expenses, 

EXPENSES  incurred  are  usually  also  paid,  but  at 
the  end  of  the  year,  there  are  quite  large  sums  particu- 
larly of  federal,  state  and  other  taxes  which  companies 
have  incurred  hy  doing  business  for  the  year  then  end- 
ing, hut  which  are  not  payable  until  some  date  in  the 
following  year,  and  which  have  not  even  been  de- 
termined when  the  year  closes.  Necessarily,  reserves 
have  to  be  set  up  for  items  of  this  character,  whether 
taxes  or  otherwise,  and  to  this  extent  incurred  expenses 
should  be  allowed  for.  In  other  words,  we  endorse  the 
method  of  the  Insurance  Commissioners  as  laid  down  for 
the  underwriting  exhibit  of  the  Convention  Annual 
Statement  Blank;  namely,  earned  premiums  against  in- 
curred losses  and  expenses. 

Experience 

Period. 

The  Proper  Number  of  Years  on  Which  to  Base  Such 
Calculation? 

Insurance  as  a business  is  governed  by  the  law  of 
averages,  and  one  year’s  experience  is  insufficient  to 
establish  a dependable  experience.  The  laws  of  such 
states  as  have  recently  made  enactments  on  the  subject, 
as  for  example,  Arkansas  and  Colorado,  have  recognized 
that  a five-year  period  is  the  minimum  over  which  a 
dependable  experience  of  underwriting  profit  or  loss 
can  be  established. 

Federal  Taxes 

SECOND 

WHETHER  IN  SUCH  CALCULATIONS  INCOME 
AND  EXCESS  PROFITS  TAXES  ARE  TO  BE 
ALLOWED  AS  AN  EXPENSE? 

Federal  income  and  excess  profits  taxes  are  among 
the  heaviest  burdens  as  to  expense  under  which  the  com- 
panies labor.  Some  states  also  have  enacted  taxes  of 
like  character.  It  is  clear  that  no  determination  of 
profit  can  be  made  which  ignores  these  very  heavy  items 
of  expense.  It  is  idle,  as  weU  as  unjust,  to  compute  a 

4 


paper  profit  from  which  further  deductions  must  be 
made  before  an  actual  profit  is  available  as  a result  of 
doing  business,  to  the  parties  whose  capital  is  hazarded 
in  the  enterprise.  All  deductions  of  losses  and  expenses 
should  be  made  before  the  production  of  any  figure  re- 
garded as  profit. 

No  corporation  organized  for  profit  and  depending 
for  its  existence  upon  a reasonable  return  to  its  stock- 
holders from  its  operations  could  continue  if  due  credit 
were  not  given  for  all  costs  of  operation  which  go  to  re- 
duce the  amount  of  its  net  income,  upon  which  its  return 
to  stockholders  is  predicated. 


THIRD 

WHETHER  ANY  ITEMS  OF  PROFIT  OR  LOSS  CON- 
NECTED WITH  THE  SO-CALLED  BANKING 
END  OF  THE  BUSINESS  SHOULD  PROPERLY 
BE  TAKEN  INTO  CONSIDERATION? 

Stock  fire  insurance  is  carried  on  by  companies  hav- 
ing a capital  stock  divided  into  shares  contributed  not 
by  the  policyholders  in  any  part  but  solely  by  the  stock- 
holders. The  business  is  managed  by  directors  chosen 
solely  by  the  stockholders  and  in  which  the  policyholder 
has  no  interest  or  voice.  Every  policyholder  in  such  a 
company  enters  into  his  engagements  with  the  company 
as  such  without  regard  to  any  other  policyholder.  He 
pays  the  premium  upon  his  policy  not  for  the  purpose 
of  insuring  any  other  person  but  solely  as  a consideration 
for  his  own  insurance  and  the  indemnity  he  is  to  receive 
in  case  of  loss.  The  company  receives  the  money  as  its 
own  and  holds  it  as  its  own  and  may  do  with  it  what  it 
sees  fit,  except  as  it  is  restrained  by  some  statute.  It  is 
wholly  immaterial  to  the  insured  what  the  company  does 
with  the  money  or  what  disposition  it  makes  of  it,  pro- 
vided it  remains  solvent  and  is  in  position  at  all  times  to 
pay  any  contractual  obligation. 


Non-ParticipO' 

tion. 


5 


Accounting 
Treatment  of 
Investment 
Earnings. 


Distinction 
Between  Profits 
From  Opera- 
tions and  Re- 
turns from 
Investments. 


Underwriting 
Subject  to 
Charges  in 
Favor  of 
Investments. 


There  is  nothing  in  the  organization  or  conduct  of 
a stock  company  which  gives  the  right  to  a policyholder 
to  expect  any  participation  in  the  earnings  of  the  com- 
pany, whether  it  he  investment  earnings  or  otherwise, 
and  there  is  no  substantial  difference,  so  far  as  partici- 
pation is  concerned,  between  the  actual  return  of  a part 
of  such  investment  earnings  and  the  application  of  a 
part  of  the  investment  earnings  to  the  reduction  of  rates. 

Stockholders  are  entitled  to  a profit  for  assuming 
the  hazard  against  loss,  this  being  the  particular  enter- 
prise the  company  engages  in.  If  they  also  put  up  large 
sums  of  money  which  are  held  invested,  return  on  such 
investments  has  nothing  to  do  with  the  results  of  under- 
writing. If  the  stockholders  choose,  they  could  invest 
the  money  in  the  same  securities  without  subjecting 
their  investment  to  the  chance  of  loss  due  to  the  hazards 
of  the  insurance  business,  and  without  going  to  the 
trouble  and  expense  of  conducting  the  insurance  busi- 
ness. Clearly  there  would  be  no  incentive  to  engage  in 
the  business  of  insurance  if  this  income  which  they 
could  obtain  from  their  investments  in  any  case  is  not 
recognized  as  a rightful  return  to  the  stockholders  irre- 
spective of  what  they  gain  or  lose  from  their  contracts 
of  indemnification  against  loss.  Furthermore,  if  the 
underwriting  end  of  the  business  is  to  be  credited  with 
the  proceeds  of  the  investment  branch,  it  will  be  found 
that  there  are  a number  of  conditions,  penalties,  and 
handicaps  under  which  the  investment  branch  of  the 
business  is  placed  for  the  benefit  of  and  to  promote  the 
business  of  the  underwriting  branch.  The  sums  with 
which  underwriting  will  have  to  be  charged  will  prob- 
ably exceed  the  sum  with  which  it  will  be  credited  by 
beginning  a series  of  charges  and  credits  between  the 
two  branches  of  the  business,  which  would  also  create 
a confusion  in  terms. 


6 


The  argument  that  income  from  funds  comprising 
unearned  premium  reserve  is  underwriting  income,  rests 
upon  the  premises  that  while  earned  premiums  alone 
are  considered  in  computing  underwriting  profit  or 
loss,  full  premiums  are  actually  collected  in  advance; 
and  such  collection  in  advance  of  the  time  when  earned, 
of  premiums  on  the  steady  flow  of  business,  maintains 
constantly  in  the  hands  of  the  companies,  funds  of  many 
millions  of  dollars  which  yield  an  income  to  the  com- 
panies, but  for  the  use  of  which  they  do  not  have  to  pay. 

But  should  losses  from  bad  investments  be  charged 
to  underwriting  result?  Should  declines  in  market 
values  be  charged  to  underwriting  result?  Doubt- 
less the  advocates  of  the  plan  suggested  by  question 
“THIRD”  will  answer — “no.  If  you  lose  the  money  the 
policyholder  prepays  you,  that  has  nothing  to  do  with 
underwriting.  The  selection  of  bad  investments  is  a 
hazard  of  the  investment  end  of  the  business.  The 
choice  of  investments  which  decline  in  value  is  a hazard 
of  the  investment  department.  These  gains  or  losses 
have  to  do  with  skill  in  choosing  investments  and  have 
nothing  to  do  with  underwriting.”  Thus,  they  would 
wish  the  companies  to  credit  the  underwriting  result 
with  the  regular  earnings  from  the  investments,  whereas 
losses,  if  any,  would  be  charged  to  the  investment 
result. 

But  are  not  the  regular  earnings  also  a matter  of  skill 
in  choosing  investments?  And  if  so,  why  should  earn- 
ings which  accrue  from  the  use  and  application  of  such 
skill  be  credited  to  underwriting  result?  Why  should 
underwriting  result  be  concerned  with  what  companies 
do  with  the  advanced  premiums?  That  has  nothing 
to  do  with  the  relation  of  premium  to  hazard,  which  is 
the  essence  of  underwriting.  A company  may  invest 
such  funds  where  they  yield  6%,  or  may  leave  them  in 
a hank  where  they  draw  but  2^,  or  may  invest  them 
where  there  is  promise  of  a good  return,  but  where, 
owing  to  any  one  of  many  possible  causes,  the  invest- 


Affirmative 

Premises. 


Investment 
Losses  and 
Depreciation. 


Interest 

Earnings. 


7 


Companies* 

Position. 


Relation  of 
Premium  and 
Hazard. 


Income  from 
Reserve  Fund- 
How  to 
Ascertain. 


ment  fails  to  make  any  return.  Why  should  underwrit- 
ing result  reflect  any  one  of  these  conditions  which  re- 
sult from  the  exercise  of  investing  judgment?  Why, 
in  short,  should  the  question  of  the  use  of  money  enter 
into  a problem  properly  involving  only  the  relation 
between  the  premium  and  the  hazard  for  which  it  is 
charged  together  with  the  expense  incident  to  doing 
the  business? 

Even  if  the  advocates  declare  their  willingness  to 
admit  the  use  of  gains  and  losses,  and  advances  and  de- 
clines in  the  market  values,  along  with  the  regular 
earnings  from  funds  comprising  the  reserve  and  contend 
that  all  these  elements  to  the  extent  that  they  affect 
unearned  premium  reserve  funds  should  be  allowed  for 
in  computing  underwriting  result,  still  the  companies 
object  for  two  reasons: 

(1st)  They  hold  that  underwriting  is  a matter 
involving  on  the  one  hand  the  premium;  on  the  other 
the  expenses  of  transacting  the  business  and  the  hazard 
of  loss.  Interest  is  not  received  except  as  funds  are 
loaned  or  invested,  and  the  loaning  and  investment  of 
funds  has  no  connection  with  the  relation  of  premium 
and  hazard; 

(2nd)  If  they  were  to  use  the  income  from  reserve 
as  a credit  to  underwriting,  how  should  it  be  ascer- 
tained? Which  investments  comprise  the  reserve  and 
which  the  surplus?  Possibly  the  method  would  be  as 
follows:  Add  the  gross  assets  at  the  beginning  and  end 
of  the  year,  and  average  them.  Add  the  reserve  at  be- 
ginning and  end  of  year,  and  average  it.  Ascertain  the 
proportion  which  the  average  reserve  bears  to  average 
gross  assets.  Assign  to  underwriting  result  such  propor- 
tion of  all  income  from  interest,  dividends  and  rents,  all 
profit  on  sales  or  redemption  of  assets,  all  increases  in 
market  values.  Charge  to  underwriting  result  such  pro- 
portion of  losses  on  sales  or  redemption  of  assets  and 
all  declines  in  market  values. 

If  a company’s  gross  assets  are  $21,000,000  and  its 


8 


reserve  $9,000,000,  by  this  plan  approximately  .4285  of 
all  investment  income  gains  and  losses  would  be  carried 
to  underwriting  result,  as  follows: 


Under- 

writing 

Invest- 

ment 

Interest,  Dividends  and 

Total 

Result 

Result 

Rents $750,000 

Gains  on  Sales  and  Re- 

$321,375 

$428,625 

demption  

Losses  on  Sales  and  Re- 

8,000 

3,428 

$324,803 

4,572 

$433,197 

demption  

Declines  in  Market 

150,000 

64,275 

85,725 

Values 

240,000 

102,840 

$167,115 

137,160 

$222,885 

The  result  demonstrates  the  absurdity  of  this  pro- 
cedure; since  actual  investment  income  is  here  so  arbi- 
trarily cut  asunder  and  partially  assigned  to  “underwrit- 
ing result,”  as  to  render  the  maintenance  of  any  dis- 
tinction between  underwriting  and  investment  results 
a mockery;  for  the  two  would  he  inextricably  inter- 
tangled,  and  neither  phrase  would  thereafter  have  any 
significance  agreeing  with  its  apparent  meaning. 

It  is  generally  understood  with  sufficient  clearness 
that  when  a new  company  enters  business,  the  amount 
which  it  is  required  to  set  aside  in  the  reserve  fund  as 
unearned,  together  with  the  expense  disbursements  it 
is  obliged  to  make  without  waiting  to  earn  the  pre- 
miums, and  such  losses  as  it  incurs  very  greatly  exceed 
the  sum  of  the  premiums  written  and  woidd  create  an 
impairment  of  capital  did  not  the  stockholders  pay  in 
enough  surplus  to  tide  it  over  this  condition  until  such 
time  as  a sufficient  earned  surplus  can  he  created,  which 
usually  requires  several  years,  perhaps  ten. 


Illustration  of 

Anomalous 

Result. 


Confusion  in 
Terms. 


Effect  of 
Reserve 
Requirements 
On  New 
Company. 


Illustration. 


Effect  of 
Reserve  Re- 
quirements on 
Established 
Company. 


For  example,  a new  company  writes  premiums  of 

$1,000,000. 

It  is  fair  to  assume  the  reserve  for  such  first  year  60^Oi 

or $600,000 

Expenses 40%  400,000 

Losses 25%  250,000 

$1,250,000 

Impairment 250,000 

Premiums  assumed  to  he  composed  of  the  following: 
Annual . $720,000  50^  reserved . $360,000 
3 years.  180,000  5/6  “ . 150,000 

5 years.  100,000  9/10  “ . 90,000 

$1,000,000  $600,000 

■It  is  not  so  generally  realized  that  the  same  condi- 
tions necessarily  exist  with  the  oldest  and  strongest  com- 
panies, having  the  largest  surplusses,  in  respect  of  the 
writings  of  each  successive  year.  After  paying  the  year’s 
expenses,  setting  aside  the  required  reserve  and  settling 
the  losses  on  current  writings  only,  the  premiums  from 
such  current  writings  will  invariably  he  exceeded.  How, 
then,  is  this  deficit  made  up,  as  regards  an  established 
company?  Not  by  the  sums  taken  out  of  the  reserve 
as  earned  on  business  written  in  previous  years,  reserves 
for  which  were  set  up  in  the  year  when  written.  The 
company  is  entitled  to  carry  these  sums  over  to  its 
earned  surplus  as  fast  as  the  fact  of  their  having  been 
earned  removes  them  from  the  reserve.  It  is  out  of  this 
earned  surplus  itself  that  each  company  must  advance 
the  funds  necessary  to  make  up  the  deficit  resulting  from 
the  combination  of  reserve,  expense  and  losses  attaching 
to  each  successive  year’s  business  put  on  the  hooks. 
Therefore  every  company,  no  matter  how  strong,  must 
suffer  a depletion  in  its  surplus  in  favor  of  the  reserve 
in  respect  of  the  business  put  on  the  hooks  in  the  cur- 
rent year,  from  that  which  the  surplus  would  otherwise 
be,  and  an  accurate  accoimting  between  the  underwrit- 
ing and  investment  departments  would  require  that 
underwriting  be  charged  and  investments  credited  with 


10 


the  use  of  the  funds  which  each  year  are  thus  borrowed 
from  the  surplus. 

To  correct  any  impression  that  60%  is  too  high  a 
reserve  to  assume  on  current  writings  in  view  of  the 
fact  that  the  reserve  funds  of  established  companies 
frequently  run  about  53%  of  their  outstanding  premi- 
ums, the  following  table  will  demonstrate  that  these 
elements  are  totally  different  and  these  percentages  not 
at  all  irreconcilable: 

For  example,  in  case  the  proportions  as  to  term 
business  were  in  detail  as  displayed  in  the  foregoing, 
the  record  for  three  years  would  be  as  follows: 

Premiums  Reserve  Illustration. 
First  year,  per  detailed  exhibit.  . . .$1,000,000  $600,000 

Second  year,  annual  business  runs 

off 720,000 

Reserve  runs  off  as  follows: 


Annual  1/2 

.$360,000 

3 years  1/3 

. 60,000 

5 years  1/5 

. 20,000 

440,000 

$ 280,000 

$160,000 

Second  year’s  writings  (same  pro- 

• portions  as  first  year) 

1,000,000 

600,000 

$1,280,000 

$760,000 

Third  year — Annual  business  runs 

off 

$720,000 

Reserve  runs  off : 

1st  year  writings : 

Annual  

3 years  1/3 

. $60,000 

5 years  1/5 

. 20,000 

2nd  year  writings: 

Annual  1/2 

$360,000 

3 vears  1/3 

. 60,000 

5 years  1/5 

. 20,000 

$520,000 

$ 560,000 

$240,000 

Third  year’s  writings 

(same  pro- 

portions  as  previous  years) . . . . , 

. 1,000,000 

600,000 

11 


$1,560,000  $840,000 


Percentage  of 

Premiums 

Reserved. 


Capital  Held 
at  Disposal  of 
Underwriting 
Operations. 


Actual 

Company 

Experiences. 


Proportion  of  reserve  to  outstanding  premiums  at 
this  point  .538,  arrived  at,  however,  hy  setting  aside  60% 
in  each  successive  year,  showing  that  this  percentage  of 
each  year’s  business  is  not  too  high  to  reflect  the  ex- 
perience of  companies.  In  fact,  the  experience  as  shown 
hy  the  following  actual  figures,  relating  to  a certain  com- 
pany’s business  for  the  year  1917,  shows  a still  higher 
per  cent  of  reserve,  namely  67.9%,  which  would  indicate 
the  theoretical  reserve  of  60%  per  the  preceding  figures 
is  probably  too  low. 

Consideration  should  also  be  given  the  amount  of 
capital  trusted  out,  not  at  interest,  in  unpaid  agent’s 
accounts  (the  amount  of  which  as  shown  in  the  annual 
statement  is  not  a fair  average  as  companies,  generally, 
make  a special  effort  to  collect  balances  before  the 
end  of  the  year),  amounts  of  capital  advanced  in  pay- 
ment of  losses  before  due,  etc.  In  short,  there  are  many 
elements  which  invested  capital  could  charge  against 
underwriting  and  if  we  open  up  the  question  of  charges 
and  countercharges,  we  shall  inevitably  have  “under- 
writing result”  and  “investment  result”  hopelessly  in- 
volved and  confused,  and  both  phrases  stripped  of  their 
plain  and  proper  meanings. 

Following  is  a graphic  illustration  of  the  relations 
between  the  imderwriting  and  investment  departments 
of  the  business,  based  upon  the  actual  experience  of  the 
company  in  question  for  the  year  1917,  so  that  the 
figures  are  not  representing  a hypothetical  case,  manu- 
factured for  the  sake  of  producing  a pre-determined 
result,  but  are  the  conclusions  drawn  from  the  actual 
transactions  of  the  year  indicated,  showing  that  if  we 
embark  on  the  policy  of  making  charges  and  counter- 
charges between  the  underwriting  and  investment  de- 
partments, we  shall  find  the  underwriting  department 
to  be  chargeable  with  very  considerable  amoimts  not 
now  charged  them,  which  presumably,  as  in  this  case, 
ivill  exceed  the  amount  of  credits  which  the  proponents 


12 


of  the  plan  to  consider  interest  on  the  reserve  would 
assign  to  the  underwriting  department. 

Net  fire  premiums  were  $10,869,735.  The  reserve 
table  shows  annual  business  on  the  books  $5,362,830. 
As  all  annual  business  in  force  at  the  end  of  the  year 
must  have  been  written  during  the  year,  and  as  botli  the 
total  net  premiums  and  the  annual  premiums  are  ex- 
pressed with  reinsurance  and  cancellations  out,  it  seems 
proper  to  deduct  the  annual  from  the  total  to  determine 
the  term  business,  which  by  this  process,  is  found  to  be 
$5,506,905.  As  the  proportion  between  three-year  and 
five-year  business  outstanding  written  during  the  year  is 
about  .685  for  three-year  and  .315  for  five-year  busi- 
ness, we  divided  the  term  premiums  above  indicated  in 
these  proportions  which  produced  $3,772,230  three-year 
premiums,  and  $1,734,675  five-year  premiums.  The  re- 
sult is  as  follows: 

Premiums  Reserve 

Annual  premiums  ...  .$5,362,830  50%  $2,681,415 


Three  years  3,772,230  83  1/3%  3,143,524 

Five  years  1,734,675  90%  1,561,208 

Total  $10,869,735  $7,386,147 


The  actual  experience  of  the  company  referred  to 
for  that  year  is  that  incurred  underwriting  expenses 
were  38  5/10%  of  the  premimns  written. 

Losses  are  not  readily  divisible  between  those  oc- 
curring under  policies  written  in  1917  and  those  under 
policies  previously  written,  so  that  an  estimate  is  neces- 
sary in  allowing  for  losses  on  the  business  of  the  current 
year,  but  experience  of  companies,  so  far  as  available, 
would  indicate  that  25%  is  a conservative  allowance  for 
losses  during  the  first  year. 

Reserve  as  indicated  above  results  in  a percentage  of 
about  67  9/10  for  the  fire  business. 

The  result  follows,  indicating  how  the  actual  gain 
from  underwriting  of  $268,226  per  the  annual  statement 


Analysis  of 
Premiums  for 
Reserve. 


Expenses. 


Losses  on 

Current 

Business, 


13 


Deficit  on 
Current  Busi- 
ness Made  Up 
From  Business 
Previously  on 
Books. 


is  divided  between  accretions  from  business  previously 
on  the  books  due  to  the  earnings  for  the  year  of  the 
premiums  on  such  business,  less  the  losses  ($3,619,488), 
as  against  impairment,  resulting  from  the  current  year’s 
business  put  on  the  hooks  subject  to  expenses,,  losses  and 
a charge  for  reserve  as  indicated  above  ($3,351,262). 


Current  Business 


Business  Previously 
on  Books 


Total 


Income 

Outgo 

Income 

Outgo 

Income 

Outgo 

Net  Premiums $11  399,603 

$11,399,603 

Losses  incurred  25% 

$2,849,901 

$2,737,635 

$5,587,536 

Expenses  incurred 
(38.5%)  

4,391,357 

4,391,357 

Reserve  67.9%  of 
fire  business) 

plus  marine  re- 
serve   

7,508,764 

$6,357,123 

1,151,641 

Misc.  items 

843 

843 

$11,399,603 

$14,750,865 

$6,357,123 

$2,737,635 

$11,399  603 

$11,131,377 

11,399,603 

2,737  635 

11,131,377 

Impairment,  re- 
sulting from  cur- 
rent business 

Net  accretion  re- 
sulting from  bus- 
iness previously 
on  the  books 

Gain  from  under- 
writing per  state- 
ment   


$3,351,262 


$3  619,488 


$268,226 


PROOF 

Net  accretions  from  business  previously  on  the  books $3,619,488 

Impairment  resulting  from  current  year’s  business  put  on  the  books - 3,351,262 

Gain  from  underwriting,  per  statement $ 268,226 


Impairment 

Repeated 

Annually. 


( 1 ) Each  year  the  new  business  put  on  the  books  will 
produce  a new  impairment,  which  will  be  made  up, 
under  favorable  conditions,  from  the  net  accretions  from 
previous  year’s  business.  But  these  accretions  belonu 
to  the  company  by  right  of  earning,  irrespective  ot 
whether  new  business  is  done  or  not.  Hence,  it  must 


\ 


14 


be  recognized  that  in  order  to  put  the  new  business  on 
its  books  the  company  has  to  advance  from  the  funds 
which  would  otherwise  be  a part  of  the  surplus  the  sum 
of  $3,351,262  and  to  advance  a like  sum  each  year. 

Underwriting  operations  are  indebted  to  capital 
elements  for  the  use  of  $3,351,262  (or  a like  sum),  con- 
tinuously, year  by  year. 

(2)  The  charges  for  commissions  and  other  charges 
in  agents’  and  general  agents’  accounts  vary  consider- 
ably. General  agency  accounts  contain  charges  of  wide 
diversity  of  character  and  amount.  Assuming  such 
charges  deducted  before  the  accounts  reach  the  company 
average  30^  of  the  net  premiums  it  follows  that  agents’ 
balances  equal  70^  of  the  net  premiums.  Agents’  bal- 
ances created  incidental  to  the  placing  on  the  books  of 
$11,399,603  net  premiums  would  thus  be  $7,979,722,  and 
as  the  average  term  of  credit  is  fully  sixty  days,  equals 
an  average  of  $1,329,953  of  the  gross  assets  continuously 
at  the  service  of  underwriting  operations,  without  inter- 
est. Hence,  underwriting  operations  are  indebted  to 
capital  elements  for  the  use  of  $1,329,953  (or  a like  sum), 
year  by  year. 

(3)  If  underwriting  operations  are  to  be  credited 
with  income  from  investments  comprising  the  reserve, 
they  must  be  charged  with  losses  on  sale  or  maturity  of 
assets  in  that  proportion  which  the  reserve  bears  to  the 
gross  assets,  as  follows: 

Loss  on  sale  or  maturity  of  ledger  assets $77,639 

Gain  on  sale  or  maturity  of  ledger  assets 5,329 

Net  loss  on  sale  or  maturity  of  ledger  assets $72,310 


Gross  assets $19,794,891 

Reserve 10,979,583 

Proportion 554 


Proportion  of  net  loss  chargeable  to  reserve $40,059 


Underwriting 
Operations 
Chargeable  with 
Amount  of 
Impairment. 


Underwriting 
Operations 
Chargeable  with 
Loss  of  Interest 
from  Idle 
Capital. 


Underwriting 
Operations 
Chargeable  with 
Losses  on 
Investments. 


15 


Underwriting 
Operations 
Chargeable  with 
Depreciation, 


Underwriting 
Operations 
Chargeable  with 
Loss  of  Interest 
From  Semi-Idle 
Capital, 


Removal  of  an 

Unwarranted 

Credit 

Now  Made  to 
Underwriting 
Operations. 


(4)  By  the  same  reasoning  underwriting  operations 
must  be  charged  with  the  loss  in  surplus  due  to  the  de- 
cline in  market  values,  which  for  the  company  in  ques- 


tion in  1917,  is  as  follows: 

Decline  in  market  values $324,529 

Proportion  (.554)  chargeable  to  reserve 179,789 


(5)  The  necessity  under  which  insurance  companies 
are  placed  to  maintain  available  cash  in  large  sums  re- 
lates primarily  to  the  steady  volume  of  losses  which  must 
be  met  and  paid  and  the  possibility  of  extraordinary 
losses,  the  means  for  payment  of  which  must  be  readily 
at  hand.  During  the  year  in  question  the  company  re- 
ferred to  kept  average  deposits  in  banks  of  about 
$2,000,000,  the  earning  capacity  of  which,  if  invested  in 
permanent  investments,  would  have  been  about  5^, 
but  which,  owing  to  the  character  of  the  business,  and 
the  necessity  for  keeping  this  sum  on  hand,  actually 
earned  less  than  2%,  resulting  in  a loss  of  over  3%  di- 
rectly chargeable  to  requirements  incidental  to  imder- 
writing.  Estimated  loss  in  interest,  chargeable  to  under- 
writing— $60,000. 

(6)  Under  the  convention  form  statement  there  is 
an  arbitrary  charge  to  investment  expenses  of  1/8  of  1^ 
oh  the  mean  invented  assets  which  represents  no 
actual  outlay,  but  evidently  what  the  brokers’  com- 
mission would  be  if  the  whole  amount  of  the  mean 
invested  assets  were  reinvested  during  the  year.  The 
only  way  this  can  be  used  as  a charge  against  invest- 
ments is  to  credit  it  to  underwriting,  and  that  is  what 
is  done,  but  underwriting  is  not  entitled  to  this  credit, 
because  the  charge  is  purely  theoretical  and  arbitrary, 
and  not  the  result  of  actual  transactions.  This  transfer 
item  for  the  company  referred  to,  in  1917,  was  $17,831. 


16 


If  charges  and  countercharges  are  to  be  made,  the 
result  will  be  as  follows,  assuming  underwriting  to  be 
credited  with  5%  on  the  average  amount  of  reserve: 

Debit  Credit 

Reserve  at  beginning  of  year,  $9,827,- 
942;  end  of  year,  $10,979,583;  total, 

$20,807,525.  Average  $10,403,762. 

Allowance  on  average  reserve  at  5%  $520,188 

Item  1.  Impairment  from  new  busi- 
ness. Use  of  $3,351,262  at  5% . . . $167,563 
Item  2.  Funds  tied  up  in  agents’  bal- 
ances; Use  of  $7,979,722  at  average 


of  60  days  equals  $1,329,953  for  one 

year  at  5% 66,497 

Item  3.  Proportion  chargeable  to  re- 
serve from  loss  on  assets  sales 40,059 

Item  4.  Proportion  chargeable  to  re- 


serve for  decline  in  market  values. . 179,789 
Item  5.  Loss  of  interest  due  to  under- 
writing requirements  for  holding 
large  sums  available  for  losses. . . . 60,000 

Item  6.  Restoration  to  underwriting 
expenses  of  the  amount  arbitrarily 
removed  therefrom  as  a charge  to 
investment  expenses  hy  the  re- 
quirements of  the  convention  form 
statement,  namely  1/8  of  1%  of 
mean  invested  assets,  about 17,000 

$530,908  $520,188 

From  the  foregoing  it  will  he  seen  that  the  possible 
charges  to  underwriting  exceed  the  possible  credits  to 
underwriting  in  case  the  question  of  accounting  between 
the  two  is  opened  up  and  charges  and  credits  are  to  be 
made. 

Developing  somewhat  further  the  conclusions  ar- 
rived at  in  the  foregoing,  the  substitution  of  the  average 


Assumption  of 
Prevailing 
Interest  Rate 
at  5%. 


Result  of 
Offsetting 
Charges  and 
Credits. 


17 


Assumption  of 
Prevailing 
Interest  rate 
of  .0417. 


Result  of 
Offsetting 
Charges  and 
Credits. 


rate  of  investment  income  earned  on  investments  for 
the  arbitrary  rate  of  5%,  produces  the  following  pos- 
sibly more  nearly  correct  results. 

This  method  differs  from  the  previous  method  only 
in  that  instead  of  assuming  an  average  interest  rate  of 
5%  we  have  taken  the  actual  income  in  its  relation  to 
income  producing  assets,  and  obtained  an  average  rate, 
which  is  .0417. 

Debit  Credit 

Reserve  at  beginning  of  year,  $9,827,- 
942;  end  of  year,  $10,979,583;  total, 

$20,807,525.  Average  $10,403,762. 

Allowance  on  average  reserve  at 

.0417  $433,836 

Item  1.  Impairment  from  new  busi- 
ness. Use  of  $3,351,262  at  .0417.  .$139,747 


Item  2.  Funds  tied  up  in  agents’  bal- 
ances; Use  of  $7,979,722  at  average 
of  60  days  equals  $1,329,953  for  one 

year  at  .0417 55,459 

Item  3.  Proportion  chargeable  to  re- 
serve from  loss  on  assets  sales 40,059 

Item  4.  Proportion  chargeable  to  re- 


serve for  decline  in  market  values. . 179,789 
Item  5.  Loss  of  interest  due  to  under- 
writing requirements  for  holding 
large  sums  available  for  losses. . . . 43,400 

Item  6.  Restoration  to  underwriting 
expenses  of  the  amount  arbitrarily 
removed  therefrom  as  charge  to  in- 
vestment expenses  by  the  require- 
ments of  the  convention  form  state- 
ment, namely  ^ of  1%  of  mean  in- 
vested assets,  about 17,000 

$475,454  $433,836 
By  this  method,  underwriting  is  to  be  charged  with 
$41,618  more  than  the  credit  amounts  to. 

18 


The  foregoing  demonstrates  that,  both  in  theory  and  Conclusions. 
in  practice,  each  new  year’s  business  put  on  the  books 
of  any  company,  however  old  and  well  established, 
creates  an  impairment,  precisely  as  it  does  in  the  case 
of  any  new  company  just  starting  in  business,  also  that 
there  are  a number  of  conditions,  penalties  and  handi- 
caps under  which  the  investment  department  of  the 
business  is  placed  for  the  benefit  of  underwriting  opera- 
tions, which,  if  there  is  to  be  an  accounting  between  the 
two  departments,  will  have  to  be  charged  against  under- 
writing. Furthermore,  that  whenever  interest  and  divi- 
dend elements  are  taken  out  of  investment  income  and 
treated  as  underwriting,  a confusion  in  terms  ensues  by 
which  the  terms  ‘‘underwriting  income”  and  “investment 
income”  become  hopelessly  confused  and  each  robbed 
of  its  proper  meaning. 


FOURTH 

DEFINE  WHAT  IS  TO  CONSTITUTE  A CONFLA- 
ORATION  AND  DETERMINE  WHAT  PART  OF 
THE  CONFLAGRATION  WOULD  BE  PROPERLY 
CHARGEABLE  TO  THE  STATE  IN  WHICH  THE 
FIRE  OCCURS. 

A conflagration  may  be  regarded  as  any  casualty  Definition  of 
which  produces  a loss  of  a million  dollars  or  more,  and  Conflagration. 
since  underwriting  profit  as  ordinarily  computed  based 
upon  ordinary  losses  makes  no  allowance  for  the  extra 
demands  upon  the  companies  for  unusual  and  abnormal 
items  of  conflagration  losses,  an  additional  margin  of 
underwriting  profit  should  be  allowed  the  companies 
annually  to  absorb  such  extraordinary  losses  as  they 
occur. 

The  total  fire  and  tornado  premiums  of  stock  com- 
panies, Mutuals  and  Lloyds,  in  the  United  States  and 
Canada  for  the  year  1917  are  reported  as  $486,650,720. 

If  we  regard  individual  losses  exceeding  $1,000,000  as 


19 


Minimum 
Allowance  for 
Conflagration 
Reserve. 


Conflagrations 
Chargeable  to 
Operations  Over 
Entire 
Country, 


conflagrations,  such  losses  constituted  over  11%  of  the 
net  premiums,  but,  of  course,  the  figures  quoted  are  the 
property  loss,  and  not  the  losses  covered  by  insurance. 
On  the  other  hand,  they  do  not  include  hail  and  tornado 
losses.  Insurance  is  yearly  becoming  more  universal. 
If  only  one-half  of  the  property  destroyed  in  the  large 
losses  in  the  future  is  covered  by  insurance,  and  such 
losses  continue  at  the  average  of  the  last  thirteen  years, 
the  conflagration  losses,  using  the  above  definition  for 
illustration,  would  be  over  5^%  of  the  net  premiums, 
and  this  is  on  fire  loss  alone,  not  taking  into  account  hail 
and  tornado.  We,  therefore,  suggest  5%  as  a very  con- 
servative minimum  reserve  against  conflagration.  Great 
conflagrations  cannot  be  charged  to  the  state  in  which 
they  occur,  for  the  purpose  of  making  rates  in  that  state 
to  produce  an  underwriting  profit.  The  San  Francisco 
loss  resulted  in  property  damage  of  $350,000,000,  which 
it  would  be  hopeless  to  expect  the  State  of  California 
to  pay  by  an  increase  in  the  insurance  rates.  Such  losses 
must  be  paid  for  by  the  premiums  of  the  entire  country, 
and  if  proper  allowance  is  made  in  each  state  for  the 
conflagration  hazard,  both  within  and  without  the  state, 
from  the  premiums  earned  in  each  such  state  (and  a 
reasonable  underwriting  profit  provided  after  such  de- 
duction), this  will  be  done. 


FIFTH 

TO  OUTLINE  A PLAN  COMPLETE  AS  TO  DETAIL, 
BY  WHICH  THE  VARIOUS  STATES  CAN  BE 
GUIDED  UNIFORMLY  IN  MAKING  THEIR  ESTI- 
MATES. 

Principles,  The  following  plan  is  based  upon  the  principles  laid 

down  in  the  Convention  Blank  for  determining  under- 
writing profit,  which  we  believe  to  be  correct; 

I.  PREMIUMS. 

I.  Gross  premiums  on  risks  written,  less  return  p re- 


20 


miums  and  premiums  for  all  reinsurances,  whether  in 
authorized  or  unauthorized  companies,  on  property  in 
the  state  during  the  year  as  reported  in  the  annual 
statements  after  allowing  for  adjustment,  if  any,  to 
include  all  reinsurances  as  defined  above. 

2.  Add  unearned  premiums  on  outstanding  business 
in  the  state  at  the  end  of  the  preceding  year. 

3.  Deduct  unearned  premimns  on  outstanding  busi- 
ness in  the  state  at  the  end  of  the  year  under  considera- 
tion. 

4.  Result:  Premiums  earned  during  the  year  under 
consideration. 

Note:  If  companies  do  not  carry  their  premium 

reserve  separately  by  states,  the  unearned  premiums 
should  he  estimated  as  follows: 

(a)  Unearned  premiums  of  whole  company  as 
of  the  date  desired  as  shown  on  Page  5 of  annual 
statements. 

(b)  Net  premiums  written  by  the  company  dur- 
ing the  year  ending  on  the  date  desired  as  shown 
on  Page  2 of  annual  statements. 

(c)  Net  premiums  written  in  the  state  for  the 
period  used  in  (b)  computed  in  the  manner  set 
forth  in  Item  1 above. 

(d)  Compute  the  ratio  of  (c)  to  (b). 

(e)  Apply  the  ratio  made  by  method  (d)  to  the 
unearned  premiums  of  whole  company  (see  a). 

Result:  Estimated  unearned  premiums  for  the  state 
under  consideration  to  be  used  under  Item  2 or  Item  3, 
above,  as  the  case  may  be. 

II.  LOSSES. 

Losses  incurred  in  the  state,  less  amounts  recovered  or 
recoverable  on  risks  reinsured,  whether  in  authorized  or 
unauthorized  companies,  as  shown  in  the  exhibit  of 
state  business  in  the  Annual  Statement  after  allowing 
for  adjustment,  if  any,  to  include  all  reinsurances  as  set 
forth  above. 


Earned 

Premiums. 


Formula. 


Incurred 

Losses. 


21 


m.  EXPENSES. 


Direct 

Expense. 


Primary 

Overhead. 


1.  Specific  Expenses.  All  agency  commissions  and 
other  agency  expenses,  taxes,  licenses,  fees,  assessments, 
membership  in  rating  bureaux  or  underwriters’  associa- 
tions, if  any,  operating  in  compliance  with  or  permitted 
by  law,  advertising  required  by  law,  special  agents’ 
salaries  and  expenses,  loss  adjustment  expenses,  expenses 
for  litigation  or  legal  advice,  maps,  inspections,  surveys 
and  other  expenses  incurred  and  paid  directly  and  speci- 
fically for  the  purpose  of  doing  business  in  the  state 
under  consideration. 

2.  General  Expenses.  That  proportion  of  general  or 
overhead  expenses  such  as  salaries  of  officers  and  home 
office  employees,  printing  and  stationery,  federal  gov- 
ernment taxes,  postage,  telegrams,  telephone  and  ex- 
press, mercantile  reports,  advertising,  home  office  main- 
tenance expenses  including  light,  heat,  janitor  service, 
etc.,  furniture  and  fixtures,  books  of  account,  and  other 
expenses  not  chargeable  to  the  business  in  any  particular 
state,  which  the  net  premiums  received  from  business 
in  the  state  under  consideration  hear  to  all  net  pre- 
miums received  by  the  company  for  the  current  year. 


Adjustment  to 

Incurred 

Basis. 


3.  Incurred  Expenses.  In  order  to  put  Item  2 on  an 
incurred  basis,  there  should  be  included  therein  not  only 
expenses  of  the  character  enumerated  and  described 
when  actually  paid,  but  also  those,  liability  for  which 
has  been  incurred  and  is  capable  of  determination  or 
estimate  at  the  time  of  making  up  the  annual  statement. 
Hence,  the  items  on  Page  5 of  the  Annual  Statement, 
representing,  respectively,  “Salaries,  rents,  expenses, 
bills,  accounts,  fees,  etc.,  due  or  accrued,” — “Estimated 
amount  hereafter  payable  for  federal,  state  and  other 
taxes  based  upon  the  business  of  the  year  of  this  state- 
ment,” and  “contingent  commissions  or  other  charges 
due  or  accrued”  should  be  taken  into  consideration,  and 
on  the  increase  or  decrease  in  such  items  during  the 
year  a like  proportion  to  that  provided  in  Item  2 for 
general  expenses  paid  should  be  figured,  and  the  result 


22 


should  be  used  to  increase  the  expenses  if  the  above 
reserves  showed  an  increase,  or  to  reduce  the  expenses 
if  they  showed  a decrease. 

4.  Departmental  Expenses.  If  the  business  in  the 
state  under  consideration,  or  any  part  thereof,  is  oper- 
ated through  a departmental  office,  or  is  subject  to  ex- 
penses incurred  in  common  with  the  business  in  some 
other  state  or  group  of  states,  and  not  separated  and 
specifically  charged  to  the  results  of  each  individual 
state,  such  secondary  overhead  expenses  should  be  dis- 
tributed among  the  states  for  which  they  were  incurred 
by  a like  process  to  that  employed  for  the  distribution 
of  general  expenses  or  primary  overhead  expenses,  as 
outlined  in  paragraph  2;  the  only  difference  being  that 
in  this  case  the  distribution  is  confined  to  the  results 
of  the  limited  number  of  states  involved,  in  the  propor- 
tion that  the  premiums  received  on  business  in  each, 
bears  to  the  sum  of  the  premiums  received  on  business 
in  all  of  them. 

IV.  ALLOWANCE  FOR  CONFLAGRATION  HAZARD. 

No  formula  for  computing  underwriting  profit  or 
loss  is  correct  which  does  not  allow  for  the  unusual  and 
extraordinary  losses  commonly  called  conflagrations,  but 
which  should  include  large,  general  and  sweeping  losses 
by  hail  and  tornado  as  well  as  by  fire.  Recently  enacted 
laws  clearly  recognize  this  principle.  For  example — 
that  enacted  in  Colorado  in  the  Legislative  Session 
of  1919,  provides  as  follows:  “In  determining  the  ques- 
tion of  a reasonable  underwriting  profit,  the  Commis- 
sioner of  Insurance,  as  a protection  to  policyholders, 
shall  give  proper  and  reasonable  consideration  to  the 
conflagration  liability  within  and  without  the  state.” 

V.  UNDERWRITING  PROFIT. 

The  remainder  of  net  premiums  earned  (I),  after 
deducting  losses  (II),  expenses  (III)  and  allowance  for 
conflagration  hazard  (IV),  will  be  the  underwriting 


Secondary 

Overhead. 


Necessity  for 
Consideration 


Precedents. 


Derivation. 


23 


Formula. 


profit — ^which  the  answer  to  question  “First”  specifies 
should  equal  5^  of  the  net  premiums  earned,  viz.: 

Earned  Premiums  (Net)  

Incurred  Losses  (Net)  

Expenses  Incurred: 

Specific  

General  

Departmental  

Total  Expenses  

Allowance  for  Con- 
flagration Hazard  

Underwriting  profit  or  loss  


‘■iii 

I 


24 


APPENDIX  DEFINING  THE  LEGAL  STATUS  OF 
THE  UNEARNED  PREMIUM  RESERVE  OF 
STOCK  FIRE  INSURANCE  COMPANIES 

The  courts  in  the  various  states  have  many  times 
been  called  upon  to  determine  the  legal  status  of  this 
reserve,  and  have  uniformly  held  that 

First:  It  is  the  exclusive  property  of  the  company 

and  not  such  as  is  held  in  trust  for  the  benefit  of  its 
policyholders ; 

Second:  The  right  of  the  insured  to  recover  a part 

of  his  premium  is  a mere  incident  of  the  contract  not 
contemplated  by  either  party  at  the  inception  of  the 
contract ; 

Third:  The  right  to  recover  is  so  remote  as  not  to 

be  worthy  of  consideration  in  determining  the  surplus 
of  the  company; 

Fourth:  A statutory  provision  that  the  so-called  un- 

earned premium  reserve  is  to  be  treated  as  a liability 
by  the  company,  and  an  insurance  commissioner  for 
the  purpose  of  bookkeeping  and  a financial  report  does 
not  change  its  character  from  an  asset  of  the  company 
to  a liability. 

In  order  to  determine  the  status  of  the  reserve  it  is 
necessary  to  determine  if  it  is  property,  and,  if  so,  to 
whom  such  property  belongs.  Of  course,  as  it  is  money 
or  its  equivalent,  it  is  property.  It  is  paid  over  by  the 
assured  to  the  company  and  treated  by  him  as  an  item 
of  expense.  He  has  lessened  the  value  of  his  assets  by 
that  sum.  The  assets  of  the  company  have  been  in- 
creased in  the  same  manner.  The  company  may  use 
it  in  the  payment  of  any  claim  or  indebtedness  of  any 
kind  which  it  may  have,  or  may  use  it  in  the  transaction 
or  furtherance  of  its  business  in  any  manner,  and  the 
proceeds  thereof  inure  solely  to  the  benefit  of  the 
company. 


Summary  of 
Decisions. 


Nature  and 
Origin  of 
Reserve. 


25 


In  the  case  of  the  People’s  Fire  Insurance  Co.  vs. 
Parker,  34  N.  J.  L.  479,  the  Supreme  Court  says: 


Effect  of 
Liability  by 
Contingency  of 
Loss. 


“It  is  liable  to  the  contingency  of  loss  upon  the 
policies  issued,  hut  it  is  as  much  the  property  of 
the  company  and  as  fully  under  its  control  as  the 
capital  stock  paid  in.  It  is  asserted  that  the  com- 
pany does  not  actually  own  these  premiums  because 
they  are  subject  to  the  risks  taken  until  the  policies 
expire  by  limitation,  and  that  this  constitutes  a 
liability  in  the  nature  of  an  indebtedness  against 
the  company.  This  consideration  cannot  affect  the 
character  of  the  fund  as  an  accumulated  surplus. 
The  liability  is  contingent;  it  may  or  may  not  ac- 
tually attach,  and,  if  it  does,  it  will  reach  to  and 
affect  the  capital  stock  and  such  premiums  as  have 
been  received  on  expired  risks  as  fully  as  those  re- 
ceived on  unexpired  risks.” 


The  Court  of  Errors  and  Appeals  of  New  Jersey 
affirmed  the  judgment  of  the  Supreme  Court,  and  in 
passing  upon  the  question  holds: 


Effect  of 
Provision  for 
Return  of 
Premium  Upon 
Cancellation, 


“The  usual  stipulation  that  in  the  event  of  a 
transfer  of  the  property  insured  and  the  termina- 
tion of  the  insurer’s  risk  a part  of  the  premium  may 
be  reclaimed,  proportionate  to  the  time  the  risk 
has  to  run  is  hut  a contingency  and  not  such  a 
charge  upon  the  premium  that  it  takes  away  the 
right  of  property  and  ownership.  Such  liability 
to  return  is  in  the  same  class  as  possible  losses  by 
fire,  against  which  provision  is  made  by  the  capital 
stock  and  the  reserve  fund  of  the  corporation,  which 
is  called  accumulated  surplus.  It  is  not  a specific 
charge  on  the  premium  paid,  hut  a possible  liability 
that  may  be  claimed  out  of  the  general  assets  of  the 
company.”  (People’s  Fire  Insurance  Co.  vs.  Parker, 
35  N.  J.  L.  575.) 


In  the  case  of  Kenton  Insurance  Company  vs.  City 
of  Covington,  86  Ky.  213,  the  court  holds  the  unearned 


26 


premium  reserve  is  the  property  of  the  company,  and 
says: 

“The  Act  of  March  12,  1870,  with  reference  to 
the  payment  of  dividends,  requiring  that  no  divi- 
dends shall  he  made  of  this  reserve  fund,  does  not 
divest  this  corporation  of  its  right  of  property  in 
it ; or  to  use  and  invest  it  for  the  benefit  of  its  stock- 
holders*' 

The  most  recent  case  touching  on  property  rights 
is  the  case  of  the  Oklahoma  National  Life  Insurance 
Company,  173  Pac.  376,  in  which  the  court  expresses 
its  opinion  as  follows: 

“We  therefore  conclude  that  the  portion  of  the 
assets  of  the  corporation  which  represents  the  re- 
serve is  as  much  the  property  of  the  corporation  as 
that  portion  which  represents  the  contributions  of 
the  stockholders  or  funds  derived  from  other 
sources.” 

In  the  case  of  the  Westchester  Fire  Insurance  Co.  vs. 
Davenport,  91  N.  Y.  575,  the  court  says: 

“To  say  that  such  receipts  constitute  a trust 
fund  held  by  an  insurance  company  for  the  use  of 
the  policyholders  or  that  it  is  a liability  of  the 
company  in  any  such  sense  * * * is  contrary  to 
reason  and  is  not  sustained  by  any  authority  known 
to  us.  The  insurer  in  fact  not  only  acquires  the 
absolute  ownership  of  such  moneys  when  received 
for  premiums,  but  is  by  the  lapse  of  time  soon  freed 
from  liability  to  repay  any  part  thereof  to  the 
policyholders  except  in  those  occasional  instances 
where  the  loss  occurs.” 

Referring  to  the  opinion  in  the  case  of  the  Detroit 
F.  & M.  Insurance  Co.  vs.  Hartz,  132  Mich.  518,  decided 
March  7,  1903,  in  which  the  court,  in  passing  upon  the 
proposition  that  the  fund  was  a liability  because,  first, 
it  is  treated  as  a liability  by  the  company  and  the  in- 
surance commissioner  for  the  purpose  of  bookkeeping 


Effect  of 
Legislation  as  to 
Payment  of 
Dividends. 


Comparison  of 
With  Other 
Capital 
Elements. 


Negation  of 

Trust 

Relation. 


Irrelevancy  of 
Statement  and 
Accounting 
Treatment  as 
Determining 
Ownership. 


27 


Further 

Decisions. 


Summary  of 
Decisions. 


and  a financial  report,  and,  second,  for  the  reason  that 
the  policies  of  the  company  are  subject  to  cancellation 
and  an  unearned  premium  may  in  that  event  be  de- 
manded by  the  insured,  said: 

“Neither  of  these  justifies  such  an  assertion. 
The  fund  called  ‘reserve  fund’  is  the  property  of 
the  company.  For  the  purpose  of  protection  to 
patrons  of  the  company,  the  law  requires  it  to  be 
kept  in  a fund  called  a ‘reinsurance  reserve  fund’ 
so  that  the  company  may  have  the  means  to  re- 
insure its  risks  if  necessary,  which  it  is  given  power 
to  do;  hut  its  character  is  not  changed  on  that 
account.” 

The  same  line  of  reasoning  is  uniformly  followed 
in  other  cases  decided  by  the  courts.  For  additional 
decisions  see  People  ex  rel  Manhattan  Fire  Insurance 
Company,  76  N.  Y.  64;  Home  Fire  Insurance  Company 
vs.  Lynch,  19  Utah  189;  Insurance  Company  vs.  Cap- 
pellar,  38  Ohio  State,  560;  City  of  Yale  vs.  Michigan 
Farmers’  Mutual  Insurance  Co.,  179  Mich.  254;  Trenton 
vs.  Standard  Fire  Insurance  Company,  77  N.  J.  L.  656. 

It  is  evident  from  the  above  that  the  courts  uniformly 
and  properly  held  that  the  unearned  premium  reserve 
is  the  property  of  the  corporation.  It  is  further  evi- 
denced by  the  fact  that  the  requirement  of  the  various 
states  does  not  deprive  a claimant  of  his  right  to  attach 
such  moneys  nor  prohibit  a company  from  using  same 
to  meet  any  of  its  obligations  other  than  the  payment 
of  dividends.  It  is  as  available  for  the  payments  of 
any  claim  as  the  moneys  paid  in  for  capital  stock  or 
derived  from  any  other  sources.  By  every  test  this  re- 
serve is  as  truly  the  property  of  the  company  as  the 
surplus  paid  in  by  the  stockholders,  and  there  is  no 
more  obligation  on  the  part  of  the  company  to  meet 
its  claims  from  this  reserve  than  there  is  from  its  paid- 
in  surplus  or  capital.  Its  ownership  in  the  company 
is  as  entire  and  complete  as  the  ownership  in  any  other 
of  its  assets. 


28 


In  the  case  of  impairment  by  reason  of  insufficient 
assets,  the  policyholder  derives  no  greater  benefit,  nor 
has  any  special  privilege  over  any  other  claimant  in 
the  distribution  of  the  reserve.  It  is  true,  the  policy- 
holder would  have  a right  to  enforce  a claim  against  the 
receiver  if  he  had  a claim  arising  under  a policy  con- 
tract, but  he  would  be  on  the  same  plane  as  any  other 
creditor  in  the  distribution  of  the  assets  of  the  company, 
including  this  so-called  reserve. 

In  the  interest  of  brevity  we  have  not  attempted  to 
cite  all  of  the  decisions  nor  present  more  than  enough, 
we  think,  to  satisfy  the  most  skeptical  that  the  unearned 
premium  reserve  is  the  property  of  the  company  and 
is  invested  for  the  benefit  of  the  stockholders,  for,  as 
held  in  the  case  of  Kenton  Insurance  Company  vs.  City 
of  Covington  (above  cited),  an  act  with  reference  to 
the  payment  of  dividends  requiring  that  no  dividends 
shall  he  made  of  this  reserve  does  not  divest  the  cor- 
poration of  its  right  of  property  in  it,  or  to  use  it  and 
invest  it  for  the  benefit  of  its  stockholders. 


Creditors* 

Claims. 


Conclusion. 


29 


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